Business income tax measures

Corporate tax rates

No changes are proposed to the corporate income tax rates or to the $500,000 small-business income limit of a Canadian-controlled private corporation (CCPC). The general corporate rate will remain 15% and the small-business rate will remain 11%.

Remittance thresholds for employer source deductions

In an effort to help reduce the tax compliance burden, Budget 2014 proposes to reduce the frequency of remittance of source deductions for some small businesses by increasing the threshold level of average monthly withholdings.

In particular:

• $25,000 (up from $15,000) will be the threshold level giving rise to the requirement to remit up to two times per month.

• $100,000 (up from $50,000) will be the threshold level giving rise to the requirement to remit up to four times per month.

This measure will apply in respect of amounts to be withheld after 2014.

Accelerated capital cost allowance (CCA)

Class 43.2 of Schedule II to the Income Tax Regulations provides an accelerated CCA rate (50% per year on a declining-balance basis) for investment in specified clean energy generation and energy conservation equipment.

Budget 2014 proposes to expand Class 43.2 to include water-current energy equipment and equipment used to gasify eligible waste fuel for use in a broader range of applications. This measure will apply to property acquired on or after 11 February 2014 that has not been used or acquired for use before that date.

Eligible capital property

Budget 2014 outlines a proposal to simplify the income tax rules dealing with eligible capital expenditures and eligible capital receipts. The timing and implementation of this proposal will be subject to public consultation.

Currently, the rules dealing with the acquisition, disposition and amortization of eligible capital property (ECP) are overly complex. The proposal is to replace the existing ECP regime by transferring a taxpayer's existing cumulative eligible capital (CEC) pools to a new capital cost allowance (CCA) class. Generally, all of the rules applicable to depreciable property would be applicable to this new CCA class and all future eligible capital expenditures and receipts would be accounted for through this new CCA class.

Whereas currently 75% of an eligible capital expenditure is included in the taxpayer's CEC pool and deductible at the rate of 7% on a declining-balance basis, 100% of future eligible capital expenditures would be included in the new CCA class and would be deductible at a 5% rate on a declining-balance basis. As with the existing rules applicable to dispositions of depreciable property, future dispositions of ECP and other eligible capital receipts will result in the recapture of CCA and capital gains. Interestingly, this would significantly expand the ability to shelter such gains with available capital losses. Further, for Canadian-controlled private corporations, these capital gains would be subject to a higher rate of tax than would be the case under the current regime.

Transitional rules are proposed to allow for a 7% CCA rate in respect of expenditures incurred before the implementation of the new rules. In addition, a transitional measure would apply to eligible capital receipts which relate to property acquired or expenditures made before the new rules are implemented. Further, simplified transitional rules are to be considered for small businesses.

International measures

Budget 2014 includes a number of measures that reflect the government's ongoing commitment “to address international aggressive tax avoidance by multinational enterprises.” These measures include specific proposals as well as government consultations.

The specific international tax proposals are intended to ensure that Canadian financial institutions are subject to tax in respect of certain offshore derivative “insurance swaps,” that the regulated foreign financial institution exception to the foreign accrual property income rules no longer apply to non-financial institutions, and that certain back-to-back lending arrangements are subject to thin-capitalization and interest withholding tax rules.

The government is also initiating a new consultation on a specific domestic anti-treaty shopping rule, as well as more general consultation relating to international tax planning by multinational enterprises that is intended to inform Canada's participation in international discussions relating primarily to the OECD Base Erosion and Profit Shifting (BEPS) Action Plan.

Captive insurance

The Canadian foreign affiliate system contains so-called “base erosion” rules that are designed to prevent taxpayers from shifting certain Canadian-source income to foreign affiliates. When these rules apply, such income earned by a controlled foreign affiliate is considered foreign accrual property income and is taxable in the hands of the Canadian taxpayer on an accrual basis.

The specific base-erosion rule in paragraph 95(2)(a.2) is intended to prevent Canadian taxpayers from shifting income from the insurance of Canadian risks (i.e., risks in respect of persons resident in Canada, property situated in Canada or businesses carried on in Canada) to foreign affiliates. Budget 2014 proposes to modify this rule so that it applies to arrangements sometimes referred to as “insurance swaps.” Budget 2014 describes such arrangements as transactions that generally involve transferring Canadian risks to a wholly-owned foreign affiliate of the taxpayer, which then exchanges those risks with a third party for foreign risks while at the same time ensuring that the affiliate's overall risk profile and economic returns are essentially the same as they would have been had the affiliate not entered into the exchange.

More specifically, Budget 2014 proposes to extend the base-erosion rule in paragraph 95(2)(a.2) so that it would apply where, taking into consideration relevant agreements or arrangements entered into by the foreign affiliate or a non-arm's-length person, the affiliate's risk of loss or opportunity for gain or profit in respect of foreign risks can reasonably be considered to be determined by reference to certain criteria in respect of other risks (the “tracked policy pool”) that are insured by other parties, and at least 10% of the tracked policy pool comprises Canadian risks. The referenced criteria are the fair market value of the tracked policy pool, the revenue, income, loss or cash flow from the tracked policy pool, or other similar criteria.

The proposed changes to paragraph 95(2)(a.2) closely resemble the “character conversion” rules that were originally proposed in Budget 2013 (and since enacted), insofar as both seek to curtail the use of certain derivative contracts that can alter the tax consequences of economically equivalent transactions.

The proposed changes to paragraph 95(2)(a.2) will apply to taxation years of a taxpayer that begin on or after 11 February 2014.

Offshore regulated banks

The foreign accrual property income regime generally requires that income from property earned by, and income from certain businesses carried on by, a controlled foreign affiliate of a taxpayer resident in Canada be included in the taxpayer's income on an accrual basis. Income from an investment business carried on by a foreign affiliate is included in the foreign affiliate's foreign accrual property income. Many financial services businesses would be considered investment businesses but for certain exceptions in the definition of “investment business.”

One of the exceptions (the regulated foreign financial institution exception) is for a business carried on by a foreign affiliate such as a foreign bank, a trust company, a credit union, an insurance corporation or a trader or dealer in securities or commodities, the activities of which are regulated under the laws of the country in which the business is principally carried on or another relevant foreign jurisdiction. Budget 2014 suggests that certain Canadian taxpayers that are not financial institutions are accessing the regulated foreign financial institution exception by electing to subject their foreign affiliates to regulation under foreign banking and financial laws. Those affiliates then engage in investment or trading activities on their own account (proprietary trading), as opposed to transactions for customers. Budget 2014 indicates that it is not intended that the exception apply in these circumstances.

Budget 2014 proposes to address this concern by adding new conditions for qualifying under the regulated foreign financial institution exception. More specifically, the exception will only be available if:

• The relevant taxpayer (i.e., the Canadian taxpayer in respect of which the foreign corporation is a foreign affiliate) is a Schedule I bank, a trust company, a credit union, an insurance corporation or a trader or dealer in securities or commodities that is resident in Canada and is subject to regulation by the Superintendent of Financial Institutions or a similar provincial regulator (including corporate parent companies and wholly-owned corporate subsidiaries of such institutions, that are themselves subject to the same regulation); and

• The Canadian financial institution has (or is deemed under applicable federal statute to have) at least $2 billion of equity, or more than 50% of the taxable capital employed in Canada of the taxpayer and all related Canadian corporations is attributable to taxable capital employed in a regulated Canadian business.

In effect, under the proposed change, the status of a Canadian taxpayer will be used as a proxy for whether a foreign affiliate may qualify for the regulated foreign financial institution exception. It is important to note that satisfaction of the new conditions will not guarantee application of the regulated foreign financial institution exception — rather, the new conditions are simply prerequisites, and the application of the exception will still depend on whether the foreign affiliate carries on a regulated financial services business and whether the relevant activities form part of that business.

Budget 2014 also cautions that the government will continue to monitor developments in this area, perhaps signaling that further action may be required to ensure that the regulated foreign financial institution exception is not used by taxpayers to obtain unintended tax advantages.

This measure will apply to taxation years of taxpayers that begin after 2014. For this particular measure, however, the government is inviting stakeholders to submit comments concerning its scope within 60 days of 11 February 2014.

Thin capitalization rules

In both the previous two budgets, the thin capitalization rules were significantly amended to extend and tighten their application. These rules are intended to limit the deductibility of interest on debts owing by corporations and trusts to certain specified nonresident persons where the amount of debt exceeds a 1.5 to 1 debt-to-equity ratio. In addition, Part XIII tax generally applies to interest paid or credited by a Canadian resident to a non-arm's-length nonresident. Budget 2014 proposes to extend the anti-avoidance “loans made on condition” rule to apply more broadly to so-called back-to-back loan arrangements where an intermediary is interposed between the Canadian debtor and certain nonresident persons. The Part XIII rules will also be extended to apply to this form of indebtedness.

Specifically, a new back-to-back loan rule will apply where a taxpayer is indebted to an intermediary and property is pledged by a nonresident person to the intermediary (or persons that do not deal at arm's length with the intermediary) as security for the Canadian resident's indebtedness, where the intermediary is indebted to the nonresident under a debt for which recourse is limited, or where the intermediary receives a loan from the nonresident on the condition that a loan be made to the Canadian-resident taxpayer by the intermediary. In these circumstances, the Canadian resident will be deemed to have an amount owing to the nonresident person and therefore the interest on the indebtedness will potentially be subject to the thin capital limitations and the application of Part XIII tax.

These back-to-back loan arrangement rules will apply to taxation years commencing after 2014 with respect to thin capitalization. For the purpose of Part XIII tax, the new rules will apply to amounts paid or credited after 2014.

Consultation on tax planning by multinational enterprises

Budget 2014 reiterates the government's commitment to continuing to improve the integrity of its international tax rules and its interest in obtaining views from stakeholders as to how fairness could be maintained between different categories of taxpayers (i.e., multinationals, small businesses and individuals), while maintaining an internationally competitive tax system that is attractive for investment.

The government has invited interested parties to submit comments within 120 days after 11 February 2014 with respect to the following questions:

• What are the impacts of international tax planning by multinational enterprises on other participants in the Canadian economy?

• Which of the international corporate income tax and sales tax issues identified in the BEPS Action Plan should be considered the highest priorities for examination and potential action by the government?

• Are there other corporate income tax or sales tax issues related to improving international tax integrity that should be of concern to the government?

• What considerations should guide the government in determining the appropriate approach to take in responding to the issues identified — either in general or with respect to particular issues?

• Would concerns about maintaining Canada's competitive tax system be alleviated by coordinated multilateral implementation of base protection measures?

• What actions should the government take to ensure the effective collection of sales tax on e-commerce sales to residents of Canada by foreign-based vendors – for example, should these vendors be required to register for GST/HST purposes and collect and remit tax on e-commerce sales to Canadian residents?

The stated intention of the consultation is to inform Canada's participation in international discussions, including most notably in the context of the OECD BEPS Action Plan.

Consultation on treaty shopping

Budget 2013 set out the government's concerns with the abuse of Canada's tax treaties through so-called “treaty shopping.” Budget 2013 stressed the importance of developing safeguards to ensure that taxpayers cannot make improper use of Canada's tax treaties and announced consultations to seek the views of interested parties regarding possible approaches to address treaty shopping. A consultation paper was released 12 August 2013 and stakeholders had until 13 December 2013 to provide comments.

Budget 2014 discusses certain comments received from stakeholders on the consultation paper, which primarily address two fundamental design features of any proposed anti-treaty shopping rule — i.e., whether the rule should be general or specific, and whether it should be domestic or treaty based. While briefly discussing the advantages and disadvantages of these paradigms, Budget 2014 concludes that a specific rule (such as a US-style limitation on benefits provision) would not capture “all forms of treaty shopping,” and that a treaty-based approach would not be as effective as a domestic law rule (presumably because of the inability to renegotiate treaties in a reasonable period of time). As a result, Budget 2014 signals the government's intention to move forward with a general, domestic anti-treaty shopping rule.

Budget 2014 also announces a new round of consultations regarding the specific provisions of the proposed domestic anti-treaty shopping rule. The main elements of the proposed rule are, however, already outlined in Budget 2014:

• Main purpose provision: Subject to the relieving provision, a treaty benefit would not be provided to a person in respect of an amount of income, profit or gain (the relevant treaty income) if it is reasonable to conclude that “one of the main purposes” for undertaking the transaction, or a transaction that is part of a series, that results in the benefit was for the person to obtain the benefit.

• Conduit presumption: It would be presumed, in the absence of proof to the contrary, that one of the main purposes for undertaking a transaction that results in a treaty benefit (or that is part of a series that results in the benefit) was for a person to obtain the benefit if the relevant treaty income is primarily used to pay, distribute or otherwise transfer, directly or indirectly, at any time or in any form, an amount to another person or persons that would not have been entitled to an equivalent or more favorable benefit had the person or persons received the relevant treaty income directly.

• Safe harbor presumption: Subject to the conduit presumption, it would be presumed, in the absence of proof to the contrary, that none of the main purposes for undertaking a transaction was for a person to obtain a treaty benefit if (i) the person carries on an active business in the relevant treaty jurisdiction that is substantial in relation to the activity carried on in Canada giving rise to the relevant treaty income, the person is not controlled, directly or indirectly in any manner whatever, by another person or persons that would not have been entitled to an equivalent or more favorable benefit had the person or persons received the relevant treaty income directly, or (ii) the person is a corporation or trust the shares or units of which are regularly traded on a recognized stock exchange.

• Relieving provision: If the main purpose provision applies in respect of a benefit under a tax treaty, the benefit is to be provided, in whole or in part, to the extent that it is reasonable in the circumstances.

Budget 2014 also includes examples of situations that would and would not be subject to the new anti-treaty shopping rule. Interestingly, the first three examples address factual situations that are almost identical to those found in three notable Canadian “treaty shopping” cases: Velcro, Prévost Car and MIL Investments. The taxpayer was successful in all of those cases.

Certain elements of the proposed anti-treaty shopping rule outlined in Budget 2014 are clearly drawn from Canada's existing treaties. For example, the “main purpose provision” is consistent with similar provisions that have been included in some of Canada's tax treaties (including, most recently, the treaty with Hong Kong) and elements of the “safe harbor presumption” are not dissimilar to those in the “active trade or business test” in the Canada-US Tax Treaty.

The new anti-treaty shopping consultation is open for 60 days after 11 February 2014. However, despite this relatively short timeframe, Budget 2014 also notes that the OECD is expected to issue recommendations in regard to treaty shopping in September 2014, as part of its BEPS Action Plan initiative, and that these recommendations will be relevant in developing a Canadian approach to address treaty shopping. Therefore, it is possible that the government will not move forward with a specific domestic anti-treaty shopping rule prior to considering the OECD recommendations in this regard.

Interested parties are requested to provide comments within 60 days after 11 February 2014.

Update on automatic exchange of information

An agreement between Canada and the United States was signed on 5 February 2014 under which Canadian financial institutions will be required to report to the CRA certain information that will be provided to the IRS under the Canada-US tax treaty and be subject to confidentiality safeguards. A variety of registered accounts (including RRSPs) and smaller deposit-taking institutions with assets of less than $175 million will be exempt from these reporting requirements. The CRA will also receive financial information from the US in respect of Canadian residents who hold accounts at US financial institutions.

The new reporting regime will come into effect starting in July 2014 with information exchanges beginning in 2015. This regime supplants the US unilaterally enacted Foreign Account Tax Compliance Act (FATCA) rules that would have required Canadian financial institutions and US persons holding financial accounts with such institutions to have complied with the FATCA legislation commencing on 1 July 2014.

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